Volume 7, Issue 7
The Wealth Advisor
Estate Planning for Business Owners
“Small businesses,” that is, those that have less than 500 employees, comprise 99.9 percent of all businesses in the United States. The owners of these businesses will, someday, exit their businesses due to retirement, incapacity or death. But most are so busy working that they don’t slow down and think about business succession and estate planning issues. That is one of the primary reasons that less than one-third of family businesses survive to the second generation; 65% of those fail to survive the second generation; and 90% of family businesses fail to survive the founder’s grandchildren.
The owners of small businesses often have multiple advisors, but rarely are the advisors consulted as a team with coordinated input. The team approach, however, is what produces the best results.
In this issue of The Wealth Advisor, we will explore the role of advisors in helping business owner clients plan for what is usually their client’s largest asset, their business. This issue will also explain what business succession/exit planning entails and how this planning can be coordinated with a business owner’s personal estate planning.
The advisory team can help the owner change his focus from how much he is making today to the future rewards he can be building for his family and his retirement.
Two Concepts to Start the Process
* The Year-End Review: This lets the business owner see how the business has performed over the last 10-11 months, review business profitability, and see the tax situation for the year. Often a lead-in to a year-end review is considering ways to reduce taxes in the coming year. It also provides an opportunity to discuss future risk mitigation.
* The Legal Audit: This is a review of all legal documents of the business, including organizational documents, employment agreements, leases, loan documents and guarantees, and buy/sell agreements. It provides another opportunity to look for tax savings and a way to identify potential gaps or liabilities.
Providing the data for these two reports and reviewing them with the advisory team will help force the owner to back up to examine business growth and profitability and talk about continuity issues.
Planning Tip: The business accountant/CPA has much to gain by introducing this planning process. Instead of just filing tax returns, the accountant here shows a real interest in helping the owner grow his business. There will also be additional work for the CPA/accountant, such as preparation of financial statements, budgets, projections and valuations, tax planning and business process and efficiency planning. If new business entities are created, additional tax returns will likely be needed, too.
How the Team Approach Can Help
Planning Tip: All members of the advisory team should be involved so the planning can be coordinated.
Planning Tip: Advisory team members should consider keeping their fees for the initial consultation low, or even free, as there likely will be additional paid work for them as the planning progresses.
Step One: Identify Motivation and Goals
Learning what motivates the business owner (income, wealth, identity, challenge, stimulation, satisfaction and/or pride) will help the advisory team work better with him. Also, helping the owner verbalize his goals will help him clarify priorities, avoid quick fixes, move forward by identifying a desired outcome, and focus energy on the most urgent concerns.
Typical business owner goals include the following:
Step Two: Value the Business
Step Three: Plan for Business Continuity
Step Four: Plan for Personal Wealth Preservation and Succession (Estate Planning) and Asset Protection
The advisory team should be aware that a business owner will often want to address the business planning first. (They most commonly suffer under the delusion of immortality.) Once the advisory team has assisted the owner to clarify his goals and developed a plan for his business, however, the business owner will see that his estate plan has already begun to take shape.
Considerations for the business owner’s estate plan include the growth of non-business assets; how to be “fair” to children both inside and outside of the business; minimizing and having the cash to pay estate tax; asset protection during the owner’s life and for his heirs; probate avoidance; planning for long term health care costs; and sometimes special considerations, such as a child or parent with special needs.
Step Five: Grow and Protect Business Value
Promoting its value will include increasing cash flow; developing operating systems (so that the system, not the owner, who will eventually be gone, becomes the solution); documenting sustainability of earnings (if the owner is taking all the cash out of the business, it will be harder to sell); improving company performance as measured by industry metrics; and paying down debt.
To grow the business and protect its value, it may be necessary to restructure the organization, solidify and diversify the customer base, implement strategies to grow the company, develop and protect proprietary technology, build a solid management team, and groom a successor.
It may also be worthwhile to examine and possibly change the corporate structure (S and C corporations, LLCs and partnerships). The advisory team can help the owner consider tax pros and cons, ease of operation and asset protection features of current and potential entities.
Planning Tip: Most business owners don’t think about asset protection until a claim arises. But the best time to plan, of course, is before the protection is needed. Consider discussing asset protection for both business and personal assets early in the planning process.
Planning Tip: An umbrella policy is often overlooked by business owners and is an inexpensive start toward the need for asset protection of both business and personal assets.
Step Six: Ownership Transfer
There are only two basic types of ownership transfers – to those who are in the business and to outsiders. Each has special characteristics.
Sale to Outside Buyers (Third Parties): The benefits to the owner of a sale to an outside buyer can include cash at closing, no owner financing (which eliminates financial risk), no family succession issues and the speed with which the exit can occur. However, everything must come together just right to successfully complete the sale of a small business. Far more often than not (often as a consequence of failure to plan properly), no buyer can be found who is willing to pay the owner’s price. About 20% of businesses are offered for sale, but only one in four of those actually sells. The probability of effecting a successful sale changes with the size of the business. About a third of offered businesses with annual sales of $10 million or less sell while about half of offered businesses with annual sales over $10 million sell.
Planning Tip: It can often take seven to ten years of proactive planning to successfully prepare a business for a sale to an outside party.
Sale to Children or Key Employees
Sellers Johnson Law • 1 Research Court, Suite 450 • Rockville, Maryland 20850 • (240) 988-5530